Introduction to Economic cylcle

All countries experience regular ups and downs in the growth of output, jobs, income
and spending. These fluctuations form what is known as the economic or business
cycle.

Boom
A boom occurs when real national output is rising at a rate faster than the trend rate of
growth. Some of the characteristics of a boom include:

A fast growth of consumption helped by rising real incomes, strong confidence

and a surge in house prices and other forms of personal wealth

A pick up in the demand for capital goods as businesses invest in extra capacity
to meet rising demand and to make higher profits

More jobs and falling unemployment and higher real wages for people in work

High demand for imports which may cause the economy to run a larger trade
deficit because it cannot supply all of the goods and services that consumers are
buying

Government tax revenues will be rising as people earn and spend more and
companies are making larger profits this gives the government money to
increase spending in priority areas such as education, the environment, health
and transport

An increase in inflationary pressures if the economy overheats and has a positive

output gap.

The UK enjoyed sustained growth over the last fifteen from 1993 through to the end of
2008 but for better examples of booming countries we have to look overseas. The
obvious example is China whose growth has been astonishing. And many
other emerging market countries have experienced a decade or more of phenomenally

rapid increases in the size of their economies. The BRIC countries have interested
economists interested in understanding their fast rates of growth and development. In
addition to China, the BRIC nations include Brazil, Russia and India.
Slowdown

A slowdown occurs when the rate of growth decelerates but national output is

still rising

If the economy grows without falling into recession, this is called a soft-landing.

Recession
Recession and rising unemployment

There is a risk is that productive capacity in the UK economy could be permanently

lost, as temporary job losses morph into long-term unemployment due to job-seekers
losing skills and dropping out of the labour market
Source: IMF Blog, August 2011

A recession means a fall in the level of national output i.e. a period when growth is
negative, leading to a contraction in employment , incomes and profits .

The simple definition:

o

A fall in real GDP for two consecutive quarters i.e. six months

The more detailed definition:

o

A recession is a significant decline in economic activity spread across the

economy, lasting more than a few months, normally visible in real GDP,
real income, employment, industrial production, and wholesale-retail
sales.
There are many symptoms of a recession here is a selection of key indicators:

A fall in purchases of components and raw materials from supply-chain

businesses

Rising unemployment and fewer job vacancies

A rise in the number of business failures including high profile names such as
Woolworths

A decline in consumer and business confidence

A contraction in consumer spending & a rise in the percentage of income saved

A drop in the value of exports and imports of goods and services

Deep price discounts offered by businesses in a bid to sell excess stocks

Heavy de-stocking as businesses look to cut unsold stocks when demand is

weak

Government tax revenues are falling and welfare spending is rising

The budget (fiscal) deficit is rising quickly

The difference between a recession and a depression

A slump or a depression is a prolonged and deep recession leading to a

significant fall in output and average living standards

A depression is where real GDP falls by more than 10% from the peak of the cycle
to the trough.

What are the main causes of a recession?

Recessions are unusual. To some economists they are an inevitable feature of a

market economy because of the cyclical nature of output, demand and
employment.

Every recession is different! It is undeniable that the global credit crunch has
been hugely significant in causing the downturn even though macroeconomic
policy has tried hard to prevent it.

The 2009 recession was the result of a combination of domestic and external economic
factors and forces:

The collapse of the British property boom falling house prices hit wealth and
led to a large contraction in new house building

Reductions in real disposable incomes due to wages rising less quickly than
prices

A sharp fall in consumer confidence made worse by rising unemployment

leading to an increase in household saving Keynes called this the paradox of
thrift. (see the chapter on Keynesian economics)

External events such as recession in the UKs major trading partners including
the USA (which accounts for 15% of UK trade) and the Euro Area (which has 55%
of UK trade)

UK exports declined because of recession in major trading partners and this hit
manufacturing industry and other businesses that supply export firms

Cut-backs in production have led to a negative multiplier effect causing a

decline in demand for consumer services and lower sales and profits for supplychain businesses

The credit crunch caused the supply of credit to dry up affecting many
businesses and home-owners

Falling profits and weaker demand has caused a fall in business sector capital
investment known as the negative accelerator effect.

Unemployment has started to rise early in the downturn a reflection of our

flexible labour market and sticky wages

An important evaluation point is that, in a recession, some businesses are affected

more than others.
The extent of the effects will depend on the type of business, the market it operates in
and the nature of the product sold
When real incomes are falling, we would expect to see a decline in demand for products
with a highincome elasticity of demand typically these goods and services are
regarded as luxury items by consumers, things that they might choose to do without
when the economy is having a bad time.
Demand for products with negative income elasticity (i.e. inferior goods) might rise
during a recession!
Slow Recovery for the UK

The British economy which contracted 6.4pc in the downturn, has rebounded 2.5pc, and
is still 3.9pc below its peak. This recovery is taking longer to take root than from any
20th Century recession bar the Great Depression
Source: News reports, August 2011
Recovery

A recovery occurs when real national output picks up from the trough reached at
the low point of the recession.

The pace of recovery depends on how quickly AD starts to rise after a downturn.
And, the extent to which producers raise output and rebuild their stock levels in
anticipation of a rise in demand

The state of business confidence plays a key role here. Any recovery might be
subdued if businesses anticipate that a recovery will be temporary or weak in
scale.

A recovery might follow a deliberate attempt to stimulate demand. In the UK a number

of strategies have been used to boost confidence and demand and prevent the
recession turning into a damaging depression:

Cuts in interest rates the policy interest rate fell to 0.5% in the Autumn of 2008
and they have stayed at this low level ever since (0.5% at the time of writing in
August 2012)

A rise in government borrowing the budget deficit rose above 150bn in 2009
and government borrowing is likely to remain high for some time to come
despite attempts to cut it

A policy of quantitative easing (QE) by the Bank of England to pump more money
into the banking system in a bid to increase the supply of loans now worth
more than 325 billion.

A temporary cut in the rate of VAT from 17.5% to 15% (now reversed VAT rose
to 20% in 2011)

The launch of a car scrappage scheme for older cars worth up to 2000 per car
and a consumer subsidy for households replacing their old boilers.

Why has the economic recovery in the UK economy been so weak?

The year 2009 saw the UK economy suffer a deep recession with a fall in real GDP of
4.4% and a steep rise in the unemployment rate. There was an encouraging recovery in
national output in 2009 with real GDP growing close to the estimated trend rate of
growth.
Since then however the pace of expansion in the UK economy has slowed down with
growth of only 0.7% in 2011 and even weaker growth forecast for 2012. Indeed in the
2nd quarter of 2012, data showed that the British economy had fallen into a second
recession known as a double-dip.
The level of real GDP remains well below the peak reached at the end of the last
economic cycle. Many commentators are forecasting that recovery will continue to be
slow in the next couple of years and this poses big risks for households, businesses and
the government.

200 200 2009 2010 201 201

Key economics indicators for the United Kingdom

Real GDP (% change)

3.5 -1.1 -4.4

2.1

0.7

0.5

Consumer spending (% change)

2.7 -1.5 -3.5

1.2 -1.2

0.8

Government spending (% change)

0.6

1.5

Capital investment spending (% change)

8.1 -4.8

1.6 -0.1
-

0.1 -0.7

3.1 -1.2 -0.9

13.4
Exports of goods and services (% change)

-1.3

1.3 -9.5

Imports of goods and services (% change)

-0.9 -1.2

7.4

4.6

1.9

8.6

1.2

1.5

7.9

8.1

8.6

12.2
Unemployment rate (% of labour force)
Government fiscal balance (% of GDP)

5.4

5.7

7.6

-2.8 -5.0

- -8.4 -7.7

11.0 10.3
Short-term interest rate (per cent)

6.0

5.5

1.2

0.7

0.9

1.0

Consumer price index (% change)

2.3

3.6

2.2

3.3

4.5

2.6

Balance of Payments, current account balance (% of

-2.5 -1.4 -1.5 -3.3 -1.9 -2.1

GDP)

Source: OECD World Economic Outlook, May 2012. Data for 2012 is a forecast
Why is the UK finding it hard to achieve a decent recovery in output and jobs? As always
when we study macroeconomics, there are many factors at work. The UK is an open
economy and our fortunes are affected not just by domestic events and policies but also
what is happening in the global system.

Why is GDP growth so difficult to forecast?

When economists make forecasts about the future path for an economy they have to
accept the inevitability of forecast errors. Conditions in the economy are always
changing and no macroeconomic model can hope to cope with the fluctuations and
volatility of indicators such as inflation, exchange rates and global commodity prices.
GDP growth is hard to forecast the chart above is the one produced by the Bank of
England when they publish their quarterly Inflation Report. The projection area is their
forecast, notice how the uncertainty grows as we move further from the present. In
2014, the range of probabilities for real GDP growth in the UK stretches from -1%
(recession) to over 5% (very strong growth). The graph above is a probability fan chart,
the darker the area, the higher is the probability attached to the outcome.